Your Money Matters: Kazakhstan - a 'great success'

Those of you familiar with Borat may have the impression that in Kazakhstan cars are pulled by donkeys, but the reality is quite different.

By AARON LEITNER
borat biz 88 298 (photo credit: Twentieth Century Fox via Bloomberg)
borat biz 88 298
(photo credit: Twentieth Century Fox via Bloomberg)
Those of you familiar with Borat may have the impression that in Kazakhstan cars are pulled by donkeys, but the reality is quite different. In fact, Kazakhstan, today, is viewed as one of the most exciting emerging market economies in the world. At the crossroads of cultures Kazakhstan is situated in central Asia, bordering Russia and China. Native Kazakhs, a mix of Turkic and Mongol nomadic tribes who migrated into the region in the 13th century, were rarely united as a single nation. The area was conquered by Russia in the 18th century, and Kazakhstan became a Soviet Republic in 1936. During the 1950s and 1960s agricultural development program, Soviet citizens were encouraged to help cultivate Kazakhstan's northern pastures. This influx of immigrants skewed the ethnic mixture and enabled non-Kazakhs to outnumber natives. Independence in 1991 caused some of these newcomers to emigrate, but due to relatively high birth rate, the population is growing. Stable political situation Kazakhstan is a constitutional republic with the president as the head of state and the bicameral Parliament, which is dominated by pro-presidential parties. Nursultan Nazarbayev has served as the President of Kazakhstan since the nation's independence. In May 2007, the Parliament approved a constitutional amendment that would allow Nazarbayev to seek re-election as many times as he wishes. This amendment applies specifically and only to Nazarbayev: the original constitution's proscribed maximum of two presidential terms will still apply to all future presidents of Kazakhstan. The amendment has been criticized in the West and by the Kazakh political opposition as anti-democratic, but it is expected to minimize power struggles between different local elites and to neutralize the attempts to find replacement to Nazarbayev and, thus, should be beneficial for the country's stability. As long as Nazarbayev rules the country, it should continue to enjoy stability. The president is genuinely popular within the population; the opposition is weak and segregated and does not pose any threat to Nazarbayev's rule. Political reforms are limited, but the reformed economy is growing at consistently high rates since 1999. Rapidly rising living standards, political and social stability and bright economic outlook make a prospect of large scale popular discontent highly unlikely. Vast raw materials Kazakhstan is the largest nation and economy in Central Asia, and the ninth largest country by area in the world. It is immensely rich in virtually all types of mineral reserves, particularly coal, iron ore, lead, zinc, chromium, copper, manganese, bauxite and gold. With many of these minerals, Kazakhstan has a substantial proportion of the world's total reserves. It is the largest producer among CIS states of beryllium, tantalum, barite, uranium, cadmium and arsenic. The country's hydrocarbon reserves are vast: According to 2005 data, Kazakhstan, with its reserves of 39.6 million barrels of oil, holds 3.3% of the world's proven oil reserves. Furthermore, Kazakhstan is the second largest producer of the former Soviet Union and produces 1.6% (1.36 million bpd) of the world's total oil production. The main oil fields of Kazakhstan are Tengiz, Karachaganak, Kurmangazy, Uzen and Kashagan. Among these, the Kashagan field is the largest oil field outside the Middle East and the fifth largest in the world, and it is estimated to hold 7-13 billion barrels of oil. With its 3,000 billion cubic meters of natural gas Kazakhstan holds 1.7% of world's total gas reserves. Consistent economic growth and rising investor confidence Apart from fossil fuel, minerals and metals reserves, Kazakhstan also has considerable agricultural potential with its vast steppe lands accommodating both livestock and grain production. The country's industrial sector rests on the extraction and processing of natural resources, but also on a relatively large machine building sector specializing in construction equipment, tractors, agricultural machinery, and some military items. The breakup of the USSR and a collapse in demand for Kazakhstan's traditional heavy industry products had resulted in a contraction of the economy, which lasted for several years. In 1995-97 the pace of the government program of economic reform and privatization quickened, resulting in a substantial shifting of assets into the private sector. The economy started to pick up, but real recovery begun in 1999, when the international petroleum prices started to rise. Kazakhstan has sustained very strong macroeconomic performance since the start of the decade. Annual real GDP growth has averaged over 10% and per capita incomes have now reached about five times the 1999 level in dollar terms. Employment has expanded steadily and social indicators have improved. The fiscal position has remained very strong, permitting substantial increases in public expenditures, especially social and infrastructure spending, as well as an accumulation of large savings in the National Fund (NFRK) for future generations. Although the country's external debt has risen significantly in the last decade, the debt levels excluding the intra-company debt are manageable. Public debt is at a very low level (6.5% of GDP at the end of 2006). The Kazakh banking system is privatized, although foreign participation is still low. The system's assets and credit to private sector are growing at a very fast rate: in 2006, banking sector assets grew by 97%, ahead of previous years' growth rates, more quickly than any other major emerging market. Unlike other CIS economies, Kazakhstan is not underbanked: fast growth led to rapid catch-up in penetration levels, which are now broadly in line with those of the more developed central European countries. Performance of Kazakh banks is generally strong. The increasing proportion of retail lending has supported margins; cost efficiency is good, reflective of increased scale. The quality of banks' assets is still high, but the authorities, concerned over rapid lending growth and the corresponding borrowing growth, have tightened regulation and supervision. Kazakhstan's current account has hovered around balance since 2003. The growing trade surplus (around 16% in 2006) has been offset by income debits, which are outcome of profit realization and repatriation by foreign investors. Foreign Investor activity is growing Unlike many developing countries, Kazakhstan is welcoming foreign investors into the development of its natural resources. A strong indication of this policy has been privatization: virtually the whole mining sector had been privatized by 1998. The first well in Kazakhstan was drilled by Alfred Nobel in 1899, and partnership with the West has been central to energy resource development in Kazakhstan ever since. While development of the country's enormous oil reserves has been interrupted by two world wars, a revolution and the dissolution of the Soviet system, this partnership has remained central to Kazakhstan's energy equation. Today, Kazakhstan has Product Share Agreements (PSA) with transnational companies for the development of hydrocarbon reserves in its territory. There are Chevron, BP, Italian ENI, Chinese CNPC and others taking part in energy sector of Kazakhstan. Foreign direct investment levels are high, at annual average of 9% of GDP. Kazakhstan continues to accrue significant foreign-exchange reserves and assets in the NFRK. At the end of 2006, these assets amounted to some 40% of GDP. An awakening market that has emerged. Kazakhstan's prospects are bright, and growing investors' confidence is reflected in a steady, upward move in Kazakhstan's foreign currency ratings since 2000. Kazakhstan was the first CIS country to receive investment grade rating. It is now rated "BBB" by Standard & Poor's and Fitch, and "Baa2" by Moody's. One might even use the words of Borat "great success" to describe the market that has emerged there. The Kazakhstan Stock Exchange is the country's principal stock exchange. Its name is abbreviated to KASE. Traded financial instruments are: corporate securities, government securities, instruments of repo market, foreign currencies and futures contracts. Given the dynamic nature of the young Kazakh equity market, it is important to ensure that an investment corresponds to current realities through regular review and adjustment While the oil and gas industry has a clear place among the country's leading sectors, other commodity sectors such as gold and uranium mining are becoming increasingly important for Kazakhstan, as is the financial sector. aleitner@tandem-capital.com The author is Global Investment Strategist at Tandem Capital. Yulia Vaiman, macro research analyst at Tandem Capital contributed to this report.